THE rate cut by the US Federal Reserve this month has not weakened the dollar as in past rate cuts. On the contrary, the dollar has actually appreciated against major currencies like the sterling pound, the euro apart from the domestic rupee. This is even though the Fed cut rates twice, once in November and again in December.
Usually, a rate cut compels fund managers to shift investments to other markets where the return is higher. According to a recent research report released by Kotak Mahindra Bank, the Term Auction Facility introduced by the Fed is expected to provide support to the greenback, which could have weakened sharply in the wake of the third rate cut. The infusion of $40 billion through this route would help boost the dollar against the Japanese yen and the Swiss franc (used for carry trade purposes).
Treasury officials say that domestic conditions like a wider trade deficit and lower foreign capital inflows could be forcing the rupee to weaken against the dollar. From a global perspective, the fall in the euro levels against the greenback could cause the rupee to follow suit, it is likely that the year 2008 could see rate cuts by most central banks, including the US Fed, the Bank of England, the European Central Bank and the Swiss National Bank.
Given that most central banks have taken a concerted action to infuse liquidity into the markets, the opinion about the depth of the crisis seems to have been altered. It is now felt that following the infusion of these funds, the crisis may not be that deep, as expected earlier.
ICICI Bank’s chief economist Samiran Chakraborty explained, “Movement of the US dollar in the month of December has largely been due to two reasons. One being that inflation figures for this month have been on the higher side. This has prompted market participants to believe that the Fed may not be too aggressive in its attempt to ease market conditions going forward. The other reason is the infusion of liquidity by various central banks.”
It is also being speculated that there has been a lot of dollar demand towards the closing of the year 2007. Typically, investment banks tend to book profits in dollar terms and then convert these funds into other currencies while ploughing profits back into their home countries. This has also been one reason for the dollar to weaken in the month of December in the past.
However, this year, treasury managers point out that the trend seems to have reversed. There have been instances of players booking losses and rather demanding dollars to meet their capital ratios, instead of selling dollars to buy other currencies. This has also caused the dollar to strengthen.
ABN Amro Bank’s senior economist, Gaurav Kapur, said, “There have been excessive bets on the US dollar in the recent past. However, as inflation has begun to rear its head, the case for a further rate cut is becoming less ambiguous. The dollar has been on the rise as market participants generally square up their positions as the year draws to a close.”
He further added that in case of the sterling pound, it had weakened by itself against the dollar. Growth momentum in the UK is showing signs of a slowdown, alongside a current account deficit in the third quarter which is greater than that in the US. As far as the euro and the Japanese yen are concerned, it has been largely due to positions being squared up.